FINANCIAL MARKETS ON THE DEFENSIVE ON CONCERNS OVER THE COURSE OF MONETARY POLICY

THIS MONTH’S HIGHLIGHTS

Financial markets on the defensive on concerns over the course of monetary policy , the successor of National Treasurer Omar Cruz, and the outcome of the May 14 elections.

Interest rates correct from all time lows; the stock market consolidates while the peso benefits from the usual hefty remittance flows and reviving appetite by global investors for emerging Asian market equities

An underperforming fiscal sector takes the edge off the strong showing of the other sectors of the economy.

April proved to be a much tamer month when compared with the negative yet market moving developments recorded in late February through early March. A sense of caution was nevertheless palpable, as local issues cast a shadow on near term market prospects, specifically the upcoming elections, the successor of resigned National Treasurer Omar Cruz, and the possible fiscal and monetary policy outcomes given the fiscal policy slippage in the first quarter and the double-digit liquidity expansion.

DOMESTIC ECONOMY

Areas that continued to show positive and solid gains were the following:

Inflation at 2.3% in April, bringing the first four months’ average to 2.9%. We expect inflation to inch up towards the end of the year but the average will not likely exceed the government’s 4.0 – 5.0% target.

Overseas dollar remittances which increased 25% yoy for February to reach US$1.1billion bringing year to date remittances at US$2.2billion or 22% higher than the comparable period in 2006. These remittances 7.0% in February from the 21.8% growth recorded the previous month.

Foreign direct investment inflows, based on the latest available data for January 2007, have climbed 51% yoy, which the BSP traced mainly on the substantial growth in reinvested earnings on optimism over the country’s economic prospects.

The country’s foreign exchange reserves that soared further to US$24.7 billion in end March, up US$0.2billion from end February level of US$25.5billion..

In contrast, the underperforming fiscal sector as well as the double digit expansion in domestic liquidity were areas that showed the economy’s vulnerable spots. The government exceeded its budget deficit target by P6.1billion (P52billion actual vs target of P45.8billion) in the first quarter 2007. While manageable, this was a reversal from the solid financial results that have been the hallmark of the government’s macro performance in recent years. Actual revenue collection lagged target by P18.5billion (revenues of P237.3billion vs P255.8billion) as all major collecting arms like the Bureau of Internal Revenue, the Bureau of Customs, and the Bureau of Treasury fell short of their revenue goals. If not for the restrained spending of government, which was kept at P237.3billion against the target of P255.8billion, the deficit could have been larger.

Meanwhile, the continuing double digit expansion in domestic liquidity (which in February increased by 22.4%, accelerating further to 24.6% in March ) continued to keep market players, for most of the month, guessing the policy response of the monetary authorities.

The above combined, together with election-related uncertainties and the recent surge in oil prices kept market players on the defensive. This mood was particularly evident in the government debt and equity markets as caution once again prevailed. The foreign exchange market was shielded largely by the continued strong inflows of dollar remittances.

FINANCIAL MARKETSINTEREST RATES

Interest rates rose mildly in April. Tbill rates continued to inch up in the latest Treasury Bill (Tbill) auction (April30 auction, May 2 issue). The 91-day and 6-month Tbill rate rose to 3.0% and 3.7%, up from the April 2 auction results of 2.860% and 3.509%. respectively. The BTr has rejected, for the fourth consecutive auction, all bids for the 1-year tenor. Had the BTr accepted the bids, the 1-year rate would have risen by 68bps, to 4.502%.

Upside pressure on rates was also reflected at the secondary market, with the PDST-F yield curve slightly inching up at the short end up to the belly of the curve.

The BSP announced a package of measures aimed at siphoning off excess system liquidity. Effective May 10, these measures include: encouraging GFIs such as the SSS and GSIS and GOCCs as well as the trust departments of banks to deposit funds with the BSP, and allowing the SDA placements of banks to be considered as alternative compliance with the liquidity floor requirements for government deposits, raising the possibility that former will offer more attractive rates for its SDAs. But the BSP Governor’s announcement that SDA rates will not deviate much from market should help ease pressure on local interest rates. However, election related uncertainties, along with concerns over the fiscal numbers should keep the upside bias well supported in the near term.

EXCHANGE RATE

The foreign exchange market proved resilient, cushioned by strong remittances and the reviving interest of global investors to emerging Asian equities. The peso appreciated to close at a month’s high of P47.435 on April 26 but has weakened slightly as the month-end requirements of corporations saw increased demand for the US dollar. By end of the month, the peso closed at P47.785 against the US dollar.

We expect the peso to move sideways in May. Support will come from the usual dollar remittance flows, observed to be particularly strong, in time for the opening of classes. Gains will be checked by risk averse investors as the political season draws to a close. We see the same cautious market to prevail, with market players on a wait and see mode until the counting is finished and official winners are proclaimed. An outcome that is market friendly should once again ignite buying interest in the local equities and thus, foreign exchange market./(CPTanchoco)

The information contained herein is based on sources which we believe are reliable but is not guaranteed by us. This report is provided for information purposes only and should not be construed as an offer or solicitation of an offer to buy or sell the security or currency mentioned herein. BPI and its affiliates may from time to time have positions and may buy or sell the security or currency described herein.

The information contained herein is based on sources which we believe are reliable but is not guaranteed by us. This report is provided for information purposes only and should not be construed as an offer or solicitation of an offer to buy or sell the security or currency mentioned herein. BPI and its affiliates may from time to time have positions and may buy or sell the security or currency described herein.